Wall Street Examines Fine Print in a Bill for Start-Ups

Mike Theiler/Associated PressEliot Spitzer announced, in 2003, a settlement that built a wall between analysts and bankers.

Wall Street is examining whether it will benefit from a little-known section of a broad new law that President Obama is expected to sign on Thursday.

Provisions tucked into the so-called JOBS Act, or the Jumpstart Our Business Startups, will roll back some major securities regulations and parts of a landmark legal settlement struck almost a decade ago. That 2003 settlement built a Chinese wall between Wall Street research analysts and investment bankers, an effort to prevent analysts from improperly promoting stocks to help their firms drum up business from corporate clients.

Under the new legislation, some of those restrictions would be eased when it comes to smaller companies, so-called emerging growth companies.

Wall Street senses an opportunity. Davis Polk, a large law firm that caters to Wall Street, wrote in a recent note to clients that the JOBS Act represented “the most significant legislative loosening in memory of restrictions around the I.P.O. process and public company reporting obligations.”

Almost every big bank on Wall Street, including Goldman Sachs, Morgan Stanley and Bank of America, is poring over the provisions, which some firms say will open a new front on their business model. Several firms contacted Wednesday said they were studying the JOBS Act and were eager to see how regulators would begin to interpret the legislation. One Wall Street executive familiar with the JOBS Act but who declined to be named said the law would give firms “more flexibility” in covering emerging companies.

The new legislation passed through Congress over the objections of regulators, past and present, who warned of the potential risks to investors.

“It is a bad sequel to a bad movie,” said Eliot Spitzer, the former New York attorney general. “It shouldn’t be called the JOBS Act, it should be called the Bring Fraud Back to Wall Street Act.”

Mr. Spitzer was a crucial architect of the 2003 settlement, struck after the dot-com bubble, when investors lost millions of dollars investing in companies that regulators later claimed were improperly hyped by analysts. In some cases, analysts would privately disparage the same stocks they were telling investors to buy, including in one e-mail where an analyst called a security a “piece of junk.”

Regulators contended that analysts were influenced by their investment banking colleagues who were seeking to win lucrative business from these hot companies. The settlement, some aspects of which were echoed in the Sarbanes-Oxley law and in regulations, barred any communication between bankers and analysts unless accompanied by a compliance officer, a move aimed at reducing the influence of bankers on the research.

There is concern that the JOBS Act will unwind this provision for emerging growth companies, those that have less than $1 billion in annual revenue. Lawmakers argued that the current restrictions have stifled the ability of start-up companies to raise capital and amplify their profile.

The JOBS Act also will allow banks to publish research reports about these companies while the bankers are helping take them public. The potential conflict here, regulators say, is that bankers might use research to drum up interest in the stock, which is then often sold to retail investors.

This new provision would have covered a broad range of companies that went public during the tech boom — popular start-ups like Pets.com and Webvan — which later foundered. It would have also affected a number of start-ups that have recently gone public — or are considering a public offering. LinkedIn, the professional social networking site that went public in 2011, reported annual revenue last year of $522.2 million. Pandora Radio, another big name that recently went public, reported revenue for fiscal 2012 (year ended January 2012) of $274.3 million.

Underwriting the initial public offerings of companies like these is a big business on Wall Street. Firms like Morgan Stanley, JPMorgan Chase and Goldman Sachs stand to make millions of dollars in fees when Facebook goes public this year.

Despite the apparent opportunities available in the new legislation, Wall Street is proceeding with some caution. For instance, some big American banks have told regulators in recent weeks that they were not likely to start doing research on companies that were candidates to go public, a person briefed on the matter said. The banks, the person said, are mindful that investors will sue them if they can show that analysts drafted intentionally deceptive research.

Before taking any actions, the banks are first seeking guidance from a cavalry of lawyers.

“All of the investment banks will likely want to be looking at the policies and procedures they have in place relating to research and research-investing banking interactions and trying to reconcile those with the JOBS Act,” said Glenn R. Pollner, a capital markets partner at Gibson Dunn who is advising clients on the JOBS Act. “Among other things, there is some uncertainty here as to how expansively or narrowly the S.E.C. and Finra will interpret the provisions of the JOBS Act relating to research and investment banking interaction.”

For one, the global settlement, and its broader rules of the road for analysts, is still technically intact.

Lawyers are advising the banks to tread lightly until the Financial Industry Regulatory Authority, Wall Street’s self-regulator, acts. Regulators on Wednesday said they were scanning the new law, and deciding the next steps to take.

Finra will likely relax some of it rules to comply with the JOBS act, but the regulator has not yet a timetable for finalizing any changes. The Securities and Exchange Commission is unlikely to have to change any of its rules.

Still, the JOBS Act appears to loosen financial communication more broadly. For instance, the bill will relax rules on how investment firms can market themselves to the public, reversing regulations that restrict what hedge funds and private equity firms can say publicly about their investment strategy.

Regulators were against the JOBS Act from the beginning. When the measure cleared hurdles in the House, the Securities and Exchange Commission scrambled to stop it in its tracks.

The law will “weaken investor protection,” Mary Schapiro, chairwoman of the S.E.C. warned last month.

“We should not walk backwards here,” she said. “Collusive behavior between analysts and bankers cost investors huge sums, shattered confidence in the integrity of research, and damaged the markets themselves.”

The JOBS Act is far reaching and also exempts emerging growth companies from certain disclosure and governance requirements for up to five years. It will also provide a new form of financing to start up companies.

Through what is known as crowdfunding, or the sale of small amounts of stock to many individuals, companies could solicit equity investments through the Internet or elsewhere, raising up to $1 million annually without being required to register the shares for public trading with regulators. Some see this as a big deal for entrepreneurs who can now sell their ideas without having to find a big financial backer. Others say this provision will bring a return to the boiler rooms of the days gone by where brokers peddled worthless stock to unassuming investors.

“It’s almost an experiment of sorts,” said Richard Roberts, a former S.E.C. commissioner who now represents companies affected by the JOBS Act. “If any parts are a disaster, Congress can change it.”

Robert Glauber, former head of the National Association of Securities Dealers, the precursor agency to Finra, and a lecturer at Harvard’s John F. Kennedy School of Government, says the 2003 accord was a “legal settlement” and a legislative modification is “perfectly appropriate.”

“A sweeping prohibition of certain behavior never made sense,” he said. “Easing the restrictions for a select group of companies will give us a chance to see if it provides useful information to the marketplace without investor abuse. The key is to make sure the banker-analyst relationship is properly disclosed and that the S.E.C. carefully monitors the effects of the change.”